Mar 17, 2008

DSPML Natural Resources and New Energy Fund - Overview

DSPML Natural Resources and New Energy Fund

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DSP Merrill Lynch Natural Resources and New Energy (DSPML - NRNEF) is the new fund offered by the DSPML Fund Managers. This open-ended thematic equity fund will seek to invest predominantly in companies involved in the discovery, production, development or distribution of natural resources and in companies with businesses in conventional as well as alternative energy segments.

The fund will invest at least 65 per cent in Indian securities and not more than 35 per cent overseas through the feeder route. The overseas exposure will be routed through two funds — Merrill Lynch International Investment Fund's World Energy Fund and New Energy Fund. Up to 20 per cent can be invested in debt.

Investment proposition: The fund-house seeks to capitalise on the current boom witnessed in the natural resources space, especially commodities such as metals, minerals and oil. A consumption-driven growth pattern arising in the emerging markets is likely to spur demand for natural resources. Further, the urbanisation and industrialisation process in these economies could drive demand for natural resources that are inputs for building infrastructure/generating power. The fund has highlighted that, historically, natural resources demand tends to surge within few years of GDP per capita (on purchasing power parity basis) touching $3,000. India is said to be at such an inflection point, with GDP per capita of $3,802 in 2006.

On the energy side, while increase in price of oil has impelled exploration and development activity in the oil and gas space, higher environmental awareness and need to look for fuels that have unlimited supply and that are cheaper has led to increasing investments in renewable and alternative fuels such as wind energy, bio-fuels and solar fuel cells. The new fund hopes to capitalise on these areas as well.

Comment: The NRNEF theme holds potential given the current up cycle in commodities. Power as a theme also holds potential in India, given the huge projects planned to meet the power deficit situation in the country. However, in the oil and gas sector, there appear to be limited options at present in the listed space. As Sundaram BNP Paribas and Reliance have already launched funds with a similar positioning, there may arise a risk of too many funds chasing similar ideas/stocks, thus losing out on any 'early find' advantage.

This constraint may be overcome to some extent if the fund chooses to invest in companies that enable oil activities — typically offshore drilling companies, engineering in companies that produce rigs or those that enable transport of oil and gas.

Further, the fund's commodity universe also includes water and agriculture. Technologies that enable better utilisation of water resources and improved production in agriculture may also be investment segments that could open a wider universe to the company compared to peers.

As there are not too many significant companies in the alternative fuel space in India, the fund may be using the feeder route (through the New Energy Fund) to gain exposure to these areas. While this segment, no doubt, has good prospects, internationally non-conventional energy production is now driven more through offers of incentives by governments. For instance, in the US, production tax credits are available until December 2008 for producers of wind energy. Similarly, the European Union is proposing to introduce at least a 10 per cent ethanol blending for transport fuels through granting some sops. While the latter proposal has seen some resistance, an expiry of tax production credit in the US may discourage tapping wind energy as a resource.

While this is not to doubt the potential that alternative resources hold, it remains a fact that this space at present requires a lot of regulatory and monetary support to gain significance.

The benchmarks for the World Energy Fund and New Energy Fund have returned 19 per cent and 11 per cent respectively on a compounded annual rate over five years. This suggests that the theme is not suitable for investors looking for order-of-magnitude returns. The fund can, however, serve as a diversifier into a theme that is still evolving and may be suitable for long-term investors.

The global portfolio will be invested in World Energy Fund and New Energy Fund, managed by the BlackRock Investment Managers. The latter proposes to acquire a 40 per cent stake house in the DSPML fund house in India. The BlackRock Team also invests on behalf of DSPML's World Gold Fund. This fund has returned 63 per cent since its inception in September 2007 as against the benchmark FTSE Gold Mines (CAP) Index of 37 per cent.

The NFO closes on March 27.